(Learning Objective 5: Differentiate financing with debt vs. equity) OrchardMedical Goods is embarking on a massive expansion. Assume the plans call for opening20 new stores during the next two years. Each store is scheduled to be 30% larger than thecompany’s existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1.0 million of the cashneeded for expansion. Orchard Medical must raise the remaining $4.75 million from outsiders.The board of directors is considering obtaining the $4.75 million either by borrowing at 4%or by issuing an additional 200,000 shares of common stock. This year the company has earned$5 million before interest and taxes and has 200,000 shares of $1-par common stock outstanding. The market price of the company’s stock is $23.75 per share. Assume that income beforeinterest and taxes is expected to grow by 30% each year for the next two years. The company’smarginal income tax rate is 30%.Requirements1. Use Excel to evaluate the effect the two financing alternatives will have on Orchard’s netincome and earnings per share two years from now.2. Write a memo to Orchard’s management discussing the advantages and disadvantages ofborrowing and of issuing common stock to raise the needed cash. Which method of raisingthe funds would you recommend?
(Learning Objective 5: Differentiate financing with debt vs. equity) Orchard
Medical Goods is embarking on a massive expansion. Assume the plans call for opening
20 new stores during the next two years. Each store is scheduled to be 30% larger than the
company’s existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1.0 million of the cash
needed for expansion. Orchard Medical must raise the remaining $4.75 million from outsiders.
The board of directors is considering obtaining the $4.75 million either by borrowing at 4%
or by issuing an additional 200,000 shares of common stock. This year the company has earned
$5 million before interest and taxes and has 200,000 shares of $1-par common stock outstanding. The market price of the company’s stock is $23.75 per share. Assume that income before
interest and taxes is expected to grow by 30% each year for the next two years. The company’s
marginal income tax rate is 30%.
Requirements
1. Use Excel to evaluate the effect the two financing alternatives will have on Orchard’s net
income and earnings per share two years from now.
2. Write a memo to Orchard’s management discussing the advantages and disadvantages of
borrowing and of issuing common stock to raise the needed cash. Which method of raising
the funds would you recommend?
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